Build up your funds for future generations

Chris Harland considers how life insurance can become an investment.

For a number of years, we have had the option of using what are called “Whole of Life” insurance policies to help to fund potential inheritance tax (IHT) liabilities.

Put simply, these policies are a form of insurance where annual premiums are paid in return for a guaranteed payment on death. They are structured in such a way that the proceeds do not form part of the deceased’s estate and therefore escape IHT.

In reality, this means the IHT liability is potentially reduced to the total cost of the premiums.

Traditionally, our clients have taken out life insurance for peace of mind, so they know their beneficiaries’ inheritance tax bill will be met. They haven’t necessarily considered whether the policy proceeds represent a good return on the premiums paid. With interest rates falling to record lows, it is now more appropriate than ever to view life policies as investments.

At the time of writing, the post-tax return for a 45% taxpayer, on a very long-dated UK government gilt (49 years to redemption), is only 0.8% per annum.

A couple aged 60 can obtain £1m of second-death, last-survivor, whole-of-life cover for an annual premium of £11,700, assuming standard health terms apply.  If we were to assume that one of the policyholders lives to age 109 (a very cautious assumption to match a 49 year old gilt), the return on the total annual premiums of £573,300 is just under 2.2% per annum net of tax.

To continue with this example, we could assume, more realistically, that the life expectancy of the last survivor is 95.  In our scenario above, the effective return on the total annual premiums is £409,500 – a relatively attractive 4.73% per annum net.

However, these figures also ignore the fact that the proceeds will generally fall outside of the estate, due to the policies being held in trust.  The actual return on the policy payer is effectively enhanced further by 40% (representing the IHT that would have had to be paid had the proceeds remained within the estate) in most cases.

Therefore, life policies not only provide a lump sum for your beneficiaries, but they also provide a comparatively excellent return over the period until the beneficiaries receive the money.  Life policies are a good-value option for building up funds for the next generation.